Gold Standard :: Gold's Function in World Economy

Updated on July 4, 2011

Gold Standard's

Gold's
value throughout history has been based on its price stability. For
centuries gold was the constant against which all other stores of value
were measured.

This use of gold as a yardstick was formalised in
the currency system adopted by Europe and America from the middle of the
nineteenth century until 1914 - the gold standard. As it operated in the
UK until 1914 the Bank of England was legally required to exchange
paper money for a fixed weight of gold and was bound by law to buy and
sell gold bullion at a fixed price. The price of £3-17-10 1/2d an ounce, which had been set in 1717, lasted for more than 200 years.

Under
the gold bullion standard, introduced by Winston Churchill as
Chancellor of the Exchequer in 1925 and which ran until 1931, the Bank
of England was merely required to buy and sell gold at a fixed price.
But the UK economy was not strong enough to support even this measure in
the wake of the stockmarket crash of 1929 and the ensuing depression.

Lost Opportunity Cost

The opportunity cost is defined by economists as " the cost in terms of
opportunities forgone". If you had not invested in gold, you could have
earned returns elsewhere.

Transfer of Mantle for Gold Price Stability

The
mantle of stability for the gold price passed to the US. Franklin
Roosevelt set a price of $35 an ounce in 1934. This lasted until August
1971, when Richard Nixon officially abandoned the dollar's link to
gold. American private citizens were once again allowed to own gold.

Oil Price Inflation and World Conflict Implications

In
1973 OPEC raised world oil prices, sparking off global inflation. The
gold price took off as the metal once again assumed its traditional role
as a disaster hedge.

"Hard" assets such as property and
commodities became the vogue in the 1970s and early 1980s, and the price
of gold and silver soared. Through the late eighties and early nineties
they were out of fashion. From the heights of $850 an ounce in Jan 1980, in response to
the Soviet invasion of Afghanistan and high oil prices, gold fell to
$300 in mid 1982. In 1991, despite the first Gulf War, it remained
within the range of $350 to $400, declining towards £335 in April 1992.

It
had been thought that the first Gulf War would push prices back to
their 1980 levels. Gold prices responded to inflation as the market
scrambled for physical assets. A sudden jump in oil prices, such as
might have resulted from conflict in the Middle East, could have
triggered worldwide inflation. Or so the reasoning went. In the event,
the threat to oil supplies was averted and after some initial panic
buying of gold in Japan, the rush was more to sell the gold that had
been gradually accumulated during 1990.

The second Gulf War, the conflict in Afghanistan and the inflationary impact (or not) caused by the banking meltdown of 2007 onwards has corresponded with significant increases in the price of precious metals. But are these factors now the cause of the increases in precious metal prices?

By the turn of the century gold and property had
returned to favour to the extent that today gold is priced at over $1000
per ounce.

Precious Metal Price Increases Due To Increases in Fiat

Gold had not completely
lost its safe haven role, but its function in jewellery as an item of
conspicuous consumption and so as an indicator of prosperity was as, if not more, important. So a threat to economic prosperity may have been
detrimental to gold prices. It may be that peace rather than war was
good for gold.

However, the banking crisis of recent years has meant that the basis on which a countries' financial wellbeing is established has been eroded. Both the UK and US gold reserves are depleted significantly. Since the time of the Gold Standard being removed. the quantity of paper money (fiat) in circulation has not been backed by the equivalent amount of gold reserves (specie).

Many fancy word combinations have been used to blind us to the fact that governments have been printing money with absolute disregard for the future catastrophe this will cause. Most of us are unaware that, whereas in gold standard times our paper money was backed by the equivalent value of gold, today 1 dollar is backed in the Federal Reserve by 4 cents worth of gold.

Consequences of Fiat over Specie

The consequences of having so much fiat money in circulation without the equivalent backing of specie money (gold) will be dire. Once the majority of people wake up to this situation there is the possibility of hyperinflation. There will be a flight into ownership of precious metals. These metals will be become the cornerstione of wealth and the ability to pay for goods and chattels.

This is the reason (and not war and inflation) that gold and silver prices are continuing to rise. Those that understand the implications of the current massive trend towards the production of paper money in order for governments to overcome their indebtedness, are seeking to buy gold and other precious metals in order to keep their wealth intact, for now and the future.

At the time of writing the spot price of an ounce of gold is USD1420 with every sign of the price increasing. Predictions range up to a price of USD10,000 per ounce.

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